The distinction between personal and enterprise goodwill is becoming an increasingly important aspect of business valuation. This is primarily true in conjunction with marital dissolution disputes, where an increasing number of states are requiring a separation of personal versus enterprise goodwill and excluding personal goodwill from the marital estate. The distinction can sometimes be a factor in corporate taxation, where the source of proceeds from a liquidation can be considered personal goodwill and therefore not subject to taxation.
By Shannon Pratt and Alina V. Niculita
At the last count prior to publication, the latest court cases in 28 states now regard enterprise goodwill as part of the marital estate in a dissolution, but not personal goodwill. Louisiana has even passed a statute to that effect!
The number of states whose latest court cases included both enterprise and personal goodwill as part of the marital estate has shrunk to 14. Four states say neither form of goodwill is marital, and four have not yet taken a stand on the issue.
Closely related to personal goodwill is the matter of covenants not to compete, which most, but not all, states have categorized as a personal asset, not subject to distribution, since it restricts the future activities of the spouse.
Distinction between Enterprise and Personal Goodwill
Goodwill is that intangible asset that contributes to earnings as a result of name, reputation, customer and employee loyalty, location, products, and similar factors not separately identified.
Enterprise goodwill is that part of goodwill attributable to the entity as opposed to the individual.
Personal goodwill is that part of goodwill attributable to the individual as opposed to the entity.
Enterprise Goodwill Characteristics
The following characteristics would be indicative of enterprise goodwill:
- Company has written contracts with major customers
- Company has written contracts with major suppliers
- Company has written employment and/or non-compete agreements with key employees
- Advantageous location
- Large business with formalized organizational structure, systems, and controls
- Company has formalized production methods and business systems
- Business or practice is not heavily dependent on personal service performed by the owner(s).
- Company sales result from company name recognition and/or sales force
Personal Goodwill Characteristics
The following characteristics would be indicative of personal goodwill:
- Small entrepreneurial business highly dependent on owner’s personal skills and relationships
- No non-compete or employment agreements
- Personal services provided by the owner(s) an important feature in the company’s products or services
- Sales largely dependent on owner’s personal relationship with customers
- Product and/or services know-how and supplier relationships rest primarily with the owner(s)
In a large neuropsychiatry practice that the authors valued, the doctor, who owned 100% of the stock, had largely institutionalized the goodwill. The company had a staff of about 60 doctors and therapists, some as employees and some as independent contractors. It had employment and non-compete agreements with all the department heads and key doctors. It also had contracts with all the hospitals it serviced, and most of the doctors had their own patient relationships. The doctor/owner personally saw few patients, but he negotiated the contracts with the hospitals and hired all the key professionals. The court concluded that the goodwill was 70% institutional and 30% personal.
A specialized niche insurance agency that the authors valued was the opposite. The president had personal relationships with all the underwriters and most of the larger customers. He had developed very loyal relationships with all of the largest producing agents. The agency had no contracts with any customers and no employment or non-compete agreements. In this case, most of the goodwill was found to be personal.
In the Martin Ice Cream case, a gentleman named Strassberg was the first distributor of Haagen-Dazs ice cream. He had successfully placed Haagen-Dazs ice cream in a significant number of large grocery chains. When Pillsbury bought out Haagen-Dazs they bought out all the distributor rights. The IRS determined there was a large enterprise level intangible asset. The court ruled that most of the value of the distributorship was personal to Pillbury, which saved a large amount of tax at the corporate level.
In the landmark Norwalk5 case, an accounting firm liquidated, and the IRS agent determined there had been a liquidating distribution of enterprise level intangible assets, so they assessed a tax on about $600,000 corporate gain on the distribution. Since there was no non-compete between the shareholders and the accounting firm, the court ruled that all the otherwise enterprise level intangibles that the IRS had deemed distributed at the time of the liquidation were, in fact, personal goodwill. The court stated, “We find no authority which holds that an individual’s ability is part of the assets of a corporation by which he is employed where, as in the instant case, the corporation does not have a right by contract or otherwise to the future services of the individuals.”
Avoiding the Perils of Personal Goodwill
Understanding the distinction between personal and commercial goodwill is key to anticipating whether the value of a family business will be a significant factor in your client’s case.
When to Engage a Business Valuator
Is a professional business valuation in the best interest of your client? A look at the factors that should be considered in determining whether or not a business valuation is necessary.
Business Valuation Resources, Calculating Goodwill: What is Personal and What is Professional? Teleconference January 18, 2006 with Ron Seigneur, R. James Alerding, Mark Dietrich, and Kevin Yeanoplos, available at www.BVResources.com both CD and transcript.
Business Valuation Resources, Goodwill Hunting in Divorce, 2007. A state by state summary of the leading U.S. court cases deciding the disposition of goodwill in marital dissolution.
Business Valuation Resources’ Guide to Personal v. Enterprise Goodwill, 2008, introduction by David Wood, with contributions by Jay Fishman, Mark Dietrich, James Alerding, Shannon Pratt, Noah Gordon, and Kevin Yeanoplos.
Business Valuation Resources, “Multiattribute Utility Model Accepted in Allocating Personal/Enterprise Goodwill,” Business Valuation Update, December 2006 (case abstract of In re Marriage of Alexander, 2006 Ill. App. LEXIS 836 (Ill. Ct. App. 2006)).
Dietrich, Mark. “Identifying and Measuring Personal Goodwill in a Professional Practice” CPA Expert, Part 1 Spring 2005, Part 2 Summer 2005.
Wood, David, “‘MUM’s the Word’: A Formal Method to Allocate Blue Sky Value in Divorce, Business Valuation Update, March 2007.
Shannon P. Pratt, CFA, ARM, ABAR, FASA, MCBA, CM&AA, is the founder and Alina V. Niculita, CFA, ASA, MBA, is the president of Shannon Pratt Valuations, Inc., a national business valuation firm located in Portland, OR. Dr. Pratt has more than ten books in print on various business valuation topics including valuations for marital dissolution purposes and he has testified on hundreds of occasions in various types of litigated matters including divorce cases. Ms. Niculita manages valuation engagements at Shannon Pratt Valuations, and has contributed to several business valuation books. For more information, visit www.shannonpratt.com..
*Reprinted with permission from The Lawyer’s Business Valuation Handbook: Understanding Financial Statements, Appraisal Reports, and Expert Testimony, Second Edition, Shannon P. Pratt and Alina V. Niculita, available for purchase from: http://apps.americanbar.org/abastore/index.cfm?section=main&fm=Product.AddToCart&pid=5130172
2010© by the American Bar Association. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association
 La. R.S. 9:2801.2 (2008).
 Business Valuation Resources. Goodwill Hunting in Divorce, 2007.
 See, for example, Kricsfeld v. Kricsfeld, 588 N.W.2d 210, 1999 Neb. App. LEXIS 1 (Neb. Ct. App. 1999) in which nebraska’s court of appeals looked to other jurisdictions and concluded that the covenant not to compete is not a marital asset.
 Martin Ice Cream, Co. v. Comm’r, 110 T.C. 189, 1998 U.S. Tax. Ct. LEXIS 17 (1998).
5 Norwalk v. Comm’r, T.C. Memo 1998-279 (1998).Published on: